OKX Blockchain 60 Lectures | DeFi Chapter, Episode 2: How Does Lending Work in DeFi?

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Hello everyone, I'm Xiao K. Today we'll be covering: "How Does Lending Work in DeFi?"

In the last episode, we explained that DeFi is the umbrella term for decentralized finance, which encompasses many areas such as lending, payments, insurance, and more. Today, we'll walk you through the most important area in DeFi — collateralized lending — and how it works.

As we all know, in the traditional lending market, if we want to borrow a loan from a bank, we need certain tangible assets as collateral. The bank then evaluates and reviews the assets before finally disbursing the loan. In the world of DeFi, the lending process works the same way, except the bank's role is removed and replaced by smart contract programs written in code.

Below, we'll use the leading project in the current market, MakerDAO, as an example to walk you through DeFi's collateralized lending process in detail:

Before we begin, we need to understand two key concepts. The first is DAI — think of DAI as the US dollar of the cryptocurrency world, as it can be exchanged 1:1 with the US dollar.

The second concept is MKR. MKR is the cryptocurrency issued by the MakerDAO project. It serves two purposes: one is for voting in community governance. Since the platform is decentralized, every MKR holder can participate in the platform's development and vote on any proposed rule changes. The other purpose is to serve as an interest token — if you borrow from the MakerDAO platform, you need to pay a certain amount of MKR as loan interest.

With these two concepts in mind, let's get into the main topic. Inside MakerDAO's smart contracts, there are two pools: one is called the Ether Pool, and the other is called the Collateralized Debt Position (CDP).

Step 1: If you want to lend or borrow on DeFi, you need to pledge a certain amount of digital assets as collateral (such as ETH, WBTC, USDC, and other cryptocurrencies issued on Ethereum). You deposit your ETH and other collateral assets into the first pool, the Ether Pool. The smart contract then evaluates your digital assets and returns a corresponding amount of PETH as a collateral receipt.

Step 2: Take the PETH receipt and deposit it into the second pool, the Collateralized Debt Position, to initiate a loan. During this process, the collateralized debt position generates a corresponding proportion of debt while locking up your previously deposited digital assets. Once the smart contract completes its review, it immediately releases the corresponding loan — DAI stablecoin — which you can then exchange for fiat currency in the market and spend as you wish.

When you're done using the funds and want to redeem your digital assets — entering Step 3 — you need to purchase a certain amount of MKR on the market to cover the borrowing interest. Deposit that, along with the DAI you borrowed, back into the Collateralized Debt Position pool. The collateral locked in the CDP will then be released. Finally, send a trading transaction through the smart contract to retrieve your previously deposited digital assets, such as ETH. This completes the entire lending process.

Of course, if at any point you have borrowed DAI but genuinely cannot repay, you don't need to worry about repayment. The smart contract will automatically auction your Ethereum on the market to complete the asset liquidation.

Overall, DeFi lending has its unique advantages compared to traditional lending. Actions such as asset valuation, lending review, and loan disbursement are all executed by code, making the process fairer, more secure, and saving a great deal of time. DeFi lending is currently growing at a rapid pace — from the early millions-of-dollars scale to today's multi-billion-dollar market cap. Hopefully, the future will bring even greater surprises.

Special thanks to Liu Changyong for his assistance and guidance on this episode.

Sina Weibo: @昌用老师

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